In a conversation last week with a friend who’s dealt for years in the world of microcap stocks, he said something spot on in reference to Regulation A+ offerings:
Reg A+ has all the regulatory requirements and downsides of a public company without any of the real benefits except for the ability to promote and sell stock to anybody and everybody.
Without going into the reasons typically cited for why Regulation A+ will be bad for investors, let’s talk for a minute as to why the issuers themselves are likely to find this new method for capital formation burdensome.
Unlike their public counterparts, private securities transactions–like those of Regulation A+–do not include free-trading stock. This presents a major problem, particularly for retail investors who’s investment represents a larger portion of his/her annual income than other accredited or institutional investors. Such retail investors will not only be squirrelly as a group (as we’ll explain further below), but they will also be more likely to clamor for a return on their capital more quickly.
In addition, the company itself will be limited in what they can do with the lack of liquidity. Yes, they can perform other Reg A+ offerings after another 12 months, but they lack some of the flexibility of liquidity provided to a public company (e.g. treasury stock swaps). OTC and Pink Sheets stocks aren’t exactly the most liquid markets out there, but they’re 100% more liquid than private securities issued in a Reg A+ offering.
Luckily there is a solution to the lack of liquidity, which we discuss here.
Sure the audits are not required to be PCAOB compliant like a typical public company, but the audit is required. This not only increases the cost, but it provides transparency that many private companies are not only unfamiliar with, but for which they may not wholeheartedly desire. The ongoing and regular reporting requirements of Reg A+ candidates not only presents a higher accounting cost than most smaller firms are used to, but it presents a risk of divulging information to other smaller firms on the market–firms that are likely not that much smaller or bigger in size. This presents a real competitive threat, especially if a particular startup business that has relied on Regulation A+ is releasing too much information to rivals and customers.
In short, transparency is always good for investors, but it can be a burden that internal management will need to deal with as the company attempts is planned growth trajectory.
Whenever you have an increase in both the number of shareholders and the transparency, it doesn’t bode well for completely avoiding liability, including both real and threatened litigation from both shareholders, partners and customers.
When a company is public, the potential for being sued is magnitudes higher than if the company is privately-held. And, if your company recently completed a fully-subscribed Regulation A+ offering, what is there to keep every attorney from smelling the proverbial blood in the water.
A good friend of mine runs a successful lending business that is upturning traditional business lending from banks. He and his firm recently raised a third round of over $20M from investors to assist the business in growing to the next level. As a result of the announcement, the company was almost immediately serviced with three separate lawsuits for alleged violations in their forms of marketing.
Similar scenarios are not unlikely in the world of Regulation A+ financings. Once the money is raised, the company is much more likely to be sued if they sneeze too loudly. It’s a sad, but likely truth.
The pricing and cost for Regulation A+ is likely to be restrictive for many of the smaller, less-prepared issuers. From my perspective, it actually acts as a natural deal threshold. If a company is not able to cross the simple barrier of paying for an audit, filing of the Form 1-A and preparation of the Offering Circular, then they’re likely not ready to raise $50,000,000.
If you read TechCrunch enough, you’ll begin to become numb at valuations. I don’t care who you are, but $50,000,000 is still a great deal of money. There should be a natural barrier (in this case the accounting and regulatory hurdles) that preclude many of the smallest company from
While there are those who’ll foot the bill for the cost of all the filings and audit, they’re looking for unicorn deals.
As we discussed previously, the large number of shareholders who’re likely to be included in a large Reg A+ deal presents shareholder management issues similar to that of a public company, but again–without the benefits. Dealing with a large pool of shareholders is likely not going to be within the wheelhouse of expertise for many smaller companies.
The thresholds discussed previously should help to preclude companies and company managers that are in the less-than-sophisticated arena, but it doesn’t preclude the forthcoming headache that is likely to occur as a direct result of having more shareholders than your typical private LLC.
Don’t get me wrong, I’m no Reg A+ naysayer. For all the negative press, including those in Montana and Massachusetts, I think something like Reg A+ is certainly overdue. But companies looking to embark on this currently unchartered journey will need to at least understand and prepare for some of the risks inherent in getting a deal done.